Tuesday, 10 December 2013

The Office for Budget Responsibility (OBR) has come under fire from across
the political spectrum following publication of its latest report accompanying
the Chancellor’s Autumn Statement.

The economics editor of the Financial
Times Chris Giles says there ‘is not a shred of credibility’ to the OBR
forecast that the unemployment rate will fall to 7.1% at the beginning of 2014
and stay there for over a year. As the Bank of England has identified 7%
unemployment as the threshold for possible interest rate increases, without much
conviction. But there is clearly a political merit to forecasting 7%-plus
unemployment, if no logic. It certainly saves George Osborne from having to
explain why interest rates could rise even before the economy has recovered its
pre-recession level.

The OBR admits
it has a poor forecasting record. This is hardly surprising given that it
uses the Treasury model of the economy. In all the arcane debate about
‘multipliers’ (the cumulative economic effects of government spending) a central
truth tends to be obscured. The highest multiplier admitted in the Treasury/OBR
model is just 1. This implies that no area of government spending can add to
growth at all. Since the private sector has no magic wand to render its own
investment in bridges, housing, railways or education more productive than
government, then logically it is impossible for the economy to grow at all. The
long-term decline of the British economy has been given an official rationale.

However an examination of the OBR forecasts is revealing about the real
dynamic at work in the economy.

How bad will it get?

According to the OBR over the next 5 years jobs and wages will grow and the
unemployment rate will fall. These central forecasts are shown in Table 1 below
(excerpted from the OBR’s Table 3.5 of OBR data here).

Table 1. Inflation, employment, wages and unemployment

Source: OBR

Consequently average earnings (the growth of wages and salaries divided by
the number of employees) will stagnate or even fall in real terms. Measured
against the CPI the OBR forecasts average earnings will return to 2011 levels
only at some point in 2016. Measured against the RPI, which takes housing costs
into account, real wages never recover over the forecast period.

Even this scenario seems unlikely. In a stunning reversal of both
pre-recession trends and the entire aim of austerity, the OBR is forecasting is
that the lion’s share of the recovery will go to labour, not to capital. Table 2
below shows the distribution of the growth in nominal GDP over the next 5 years
(table attached to Chart 3.20 of OBR data).

Table 2. Nominal GDP growth and its components (% contribution)

Source: OBR

Labour’s share of national income has been declining on a trend basis since
the 1970s. The purpose of austerity is to reverse the natural fall in profits
from a recession as sales fall but cost are unchanged or even rise (including
the cost of labour). Yet the OBR’s forecast of flat or falling real wages is
based on labour maintaining its share of national income or even increasing it.

Chart 1.

Perhaps the most outlandish forecast of all is reserved for the rise in
business investment. The fall
in business investment during the slump has now exceeded the entire fall in
GDP. As government and other sectors have also cut their investment this means
that total investment has now fallen far further than aggregate GDP. GDP has
fallen by £40bn since the 1st quarter of 2008, business investment is £42bn
lower and total investment has fallen by £61bn.

It is also accepted that the primary source of the OBR’s repeated
over-optimistic forecasts have been its projections for rising business
investment that have failed to materialise. Yet once again the OBR is projecting
a rise in the expenditure of firms in plant, machinery, building, transport
equipment, and so on.

Previously, SEB has shown that the investment
rate (investment as a proportion of profits) of British firms has declined
markedly over several decades. The OBR forecasts that profits as a proportion of
GDP will peak in the second half of next year at close to current levels and
that they will then gradually decline. Despite this, according to the OBR,
business investment will rise dramatically at the same time, from a new low of
7.6% of GDP in the 3rd quarter of 2013 to over 10% of GDP by the
beginning of 2019.

These trends and the OBR forecasts are shown in the Chart 2 below.

Chart 2.

Source: OBR, author’s calculations

Economic forecasting is always uncertain. But the notion that businesses will
substantially increase their rate of investment while profits trend lower is
fanciful. Businesses do not invest because it is socially necessary or even
because the economy is growing. GDP has been rising since mid-2009 and business
investment has been falling. In a market economy investment is driven by the
return on it, which is profits.

In reality there are only two main trajectories for the economy while
austerity remains in place. The first possibility is that the OBR’s assumptions
about flat or falling real wages prove wrong and wages are driven down much
further to boost profits. In that circumstance investment can rise if profits
rise first. The alternative is the current pattern, where neither profits nor
investment have recovered and a snail-like recovery takes place driven by
increased borrowing to finance consumption.

There is a third variant, which breaks from austerity. This would see the
state leading an investment based-recovery using its own resources and those of
the private sector to boost growth and productivity, create well-paid jobs and
so allow the sustainable funding of a decent social security system.

Unfortunately, without this radical change in policy, the fairytales from the
OBR are likely to be a nightmare for the overwhelming majority of the
population.